Entrepreneurs’ relief is important for all business owners, so advisers need to understand the key issues both for their clients and, in many cases, themselves as well. The relief is really valuable: the capital gains tax charge on qualifying assets is only 10 per cent. That is a rate of tax most people can easily tolerate without feeling the need to undertake elaborate avoidance planning or go abroad for long periods.
Mind you, with the rate of CGT on most assets (other than residential property and carried interest) now down to just 20 per cent for higher and additional rate taxpayers, missing out on entrepreneurs’ relief has not been quite such a disaster since 6 April this year.
There is an overall lifetime limit of £10m on the amount of gains on which you can claim the relief, but as long as you do not exceed this you can claim the relief as often as you like. What is more, spouses and civil partners can qualify separately for their own entrepreneurs’ relief if they each meet the various conditions to claim it. Trusts, however, do not have their own separate £10m limit. Trust assets can qualify but only by reference to the lifetime limits of the beneficiaries.
Several types of assets can qualify for entrepreneurs’ relief. These are as follows:
- All or part of a business owned by a sole trader or business partner, including the business’ assets after it closed.
- Shares (or securities) in a company where the person making the disposal has at least 5 per cent of the shares and voting rights (a “personal company”).
- Shares acquired through an Enterprise Management Incentive scheme after 5 April 2013.
- Assets the person making the disposal lent to their business or personal company for the trade. “Disposal” in this context often means sale but it could mean gift or even the liquidation of a personal company.
An important change made this April to entrepreneurs’ relief hit directors that wind up a solvent company. They can no longer claim entrepreneurs’ relief if they continue to work in the same trade as the company in the following two years after the liquidation. A record number of solvent companies were wound up in March in anticipation of this change.
The new rule will affect situations where a shareholding director sells the goodwill and other business assets out of their company and then puts the company into liquidation and takes the proceeds as a capital gain taxed at just 10 per cent. In such circumstances, the buyer of the underlying business might well expect the outgoing owner to continue working as a consultant for a changeover period. This could now present a problem. Clients and advisers themselves should be aware of this possibility when negotiating a deal and get advice on the matter.
Dos and don’ts
The business or company being disposed of must be trading to qualify for the relief. Some business activities do not get entrepreneurs’ relief because they are regarded as investment operations rather than trades: for example, most forms of property letting. And there can be complications where a company owns a share in a joint venture with another company. Indeed, there are some changes here in the Finance Bill.
There is some flexibility about the trading condition. Even if the company stops being a trading company, it is still possible to qualify for relief if the shares are sold within three years.
Sole traders or business partners must have owned the business for at least one year before the date on which they sell it. And if an owner is closing their business rather than selling it, they must have also owned it for at least a year before the closure. The business assets must then be disposed of within three years to qualify for relief.
For a sale of shares or securities, the seller must have been an employee, a director or some other office holder of the company being sold or one in the same group. Furthermore, for at least one year before the sale of the shares the seller must have had at least 5 per cent of shares and voting rights in the company.
The exception is shares that were acquired through an EMI scheme. The seller must have been given the option to buy the EMI shares at least one year before disposing of them.
Assets a business owner has lent to their business may also qualify for entrepreneurs’ relief. The most common example is a property that the individual business owner holds personally but has lent to the business. The conditions for such assets to qualify are that the owner must have sold at least 5 per cent of their part of a business partnership or shares in their personal company.
What is more, they must have owned the assets but allowed the business partnership or personal company to use them for at least one year up to the date of the sale or the date the business closed.
It is an inescapable fact a lot of people regard their business as their pension and fail to diversify into other assets. The risks of this strategy are considerable but the tax benefits are crucial.
Danby Bloch is chairman at Helm Godfrey